Many people want to know where the stock market is headed. To help answer this ever present question, many market forecasts are provided to market participants. Many such forecasts are based on historical price and volume data, using concepts like overbought and oversold. Others use economic and market data, trying to ascertain where the market is headed based on the current state of the economy and the markets. Still others try to gauge market sentiment by surveying investors to determine if they are more bullish or bearish. The American Association of Individual Investors (AAII) Sentiment Survey is one of the best known of these.
Overall stock market returns are driven by a wide range of return factors. These factors represent the many ways in which market participants impact stock prices by means of their trading activity. Market participants comprise all buyers and sellers. It is believed that some of these factors are associated with economy-wide changes, some are associated with stock market activity, some are associated with industry sectors, and some are associated with stock specific information. In general terms, return factors are unobservable and represent a conceptual way to think about how investors drive returns over time. Collectively, return factors drive overall market returns. Over time, the mix of factors upon which market participants focus changes. Some factor mixes produce higher market returns, while others produce lower, even negative returns. When estimating the market's expected or future return, it is important to know which return factor mix is the current focus of market participants. Embodiments of the present invention provide proxies that capture the current focus of market participants and therefore capture the return factor mix that is the current focus of market participants.
A strategy-based investment system categorizes investment managers and can also be used to categorize the investments they hold based on the strategy being pursued by the manager. The strategy based investment system categorizes investment managers and/or securities based on the way they analyze, buy, and sell assets and liabilities regardless of the name used to reference the investment manager's process. It is based on the self-described investment strategy or strategies of investment management. Investment strategy is sometimes also referred to as investment methodology, or investment technique. Investment strategy can be described in both quantitative and qualitative terms.
A strategy based investment system can be applied to any asset or liability class for which managers make investment decisions based on differing investment strategies. Asset classes that can be characterized by the strategy based investment system include, but are not limited to, mutual funds, Separately Managed Accounts or SMA's, separate accounts, hedge funds, company stocks, bonds, real estate, venture capital, commodity funds, private equity, energy funds, precious metals, international stocks, and international bonds. It is to be understood that a strategy based investment system is equally applicable to non-equity asset classes.
An individual manager's investment strategy, also referred to as a strategy profile, is generally comprised of self-selected (or manager selected) primary and secondary investment strategies. Within each strategy there will both quantitative and qualitative strategy elements which further describe the way a manager goes about analyzing, buying, and selling assets. The strategy profile for a given manager may include strategy elements from investment strategies other than the strategy elements of the primary and secondary strategies. Primary strategy refers to the investment strategy primarily, or most frequently or consistently, followed by a manager. Secondary strategy refers to the investment strategy secondarily, or, as compared to the primary strategy, next most frequently or consistently, followed by a manager. The manager is free to select as many or as few strategy elements as is needed to describe the investment process. Within the primary and secondary investment strategies, the manager can rank the relative importance of the strategy elements selected.
Active investment managers pursue an investment strategy in order to generate superior returns. This is true of equity managers, as well as investment managers involved with other asset classes. Each strategy focuses on a different subset of return factors and managers in each strategy or who pursue a particular strategy build a unique investment process around this subset of factors. As a consequence, how one strategy compares or ranks compared to other strategies vary over time as market participants, which is the entire universe of buyers and sellers, not just professional managers, focus on an ever different return factor mix. Because managers pursue their chosen strategy as consistently as possible, strategies provide a prism or lens through which the favored factor mix can be viewed. In other words, strategies stay the same but the favored factor mix is ever changing. Thus assessing a comparative rank of strategies relative to each other identifies which strategies market participants are presently favoring. This provides a proxy of market return factors, i.e., participant behavior, which is measurable, reliable and predictive.
As a threshold step in comparing strategies, it is helpful to create strategy indices. A multi-step development of the U.S. and International active equity mutual fund strategy identification process began in 2005. The first step was an initial identification effort based on collective knowledge of the industry. In the next step, equity managers, who managed or had managed a wide variety of equity funds, were interviewed in order to expand and refine the proposed identification system. Next, over 45,000 pieces of strategy information was gathered from roughly 3000 mutual fund (ignoring share classes) prospectuses.
From this information, ten (10) equity strategies were identified. These equity strategies are generally defined as follows:
Competitive Position:
Business principles, including quality of management, market power, product reputation, and competitive advantage. Consider the sustainability of the business model and history of adapting to market changes.
Economic Conditions:
Top down approach based on economic fundamentals; can include employment, productivity, inflation, and industrial output. Gauges where overall health of economy is in business cycle, resulting supply and demand situations in various industries, and best stocks to purchase.
Future Growth:
Companies poised to grow rapidly relative to others. The Future Growth and Valuation strategies are not mutually exclusive and can both be deemed important in investment process.
Market Conditions:
Consideration of stock's recent price and volume history relative to the market and similar stocks as well as the overall stock market conditions.
Opportunity:
Unique opportunities that may exist for a small number of stocks or at different points in time. May involve combining stocks and derivatives and may involve use of considerable leverage. Many hedge fund managers follow this strategy, but a mutual fund manager may also be so classified.
Profitability:
Company profitability, such as gross margin, operating margin, net margin and return on equity.
Quantitative:
Mathematical and statistical inefficiencies in market and individual stock pricing. Involves mathematical and statistical modeling with little or no regard to company and market fundamentals.
Risk:
Control overall risk, with increasing returns a secondary consideration. Risk measures considered may include beta, volatility, company financials, industry and sector exposures, country exposures, and economic and market risk factors.
Social Considerations:
Company's ethical, environmental, and business practices as well as an evaluation of the company's business lines in light of the current social and political climate.
Valuation:
Stocks selling cheaply compared to peer stocks based on accounting ratios and valuation techniques. The Valuation and Future Growth strategies are not mutually exclusive and can both be deemed an opportunity strategy, but a mutual fund manager may also be so classified.
The resulting information developed as part of the process also led to the identification of elements associated with the strategies. Elements are observable things managers do to make money. Elements are the next level down in describing a manager's strategy. Managers use elements as a way to tap into return factors. Once the data organization process was complete, primary and secondary strategies for each fund were identified. The system is explained in U.S. Pat. No. 7,734,526, the entirety of which is incorporated by reference herein. Using this system, U.S. and International active equity mutual funds domiciled in the U.S. have been strategy identified since 2007 by AthenaInvest, Inc. based in Greenwood Village, Colo. Ten (10) U.S. and ten (10) International Equity Strategy Indices were developed based on the ten strategies described above. The number (excluding share classes) of strategy identified U.S. active equity funds increased from 172 in January 1980 to 2051 by December 2010 and the number of International active equity funds increased from 11 to 746 over the same time period.